Marginal Costing

🟢 Lite — Quick Review (1h–1d)

Rapid summary for last-minute revision before your exam.

Marginal costing charges only variable costs to cost units — direct materials, direct labour, direct expenses and variable production overheads. Fixed production overheads are treated as period costs and written off in full to the contribution account for that period. The pivot metric is Contribution = Sales − Variable Cost, which is what funds fixed costs and residual profit. The headline relationship is Profit = Contribution − Fixed Cost. Two must-know outputs of CVP analysis are the Break-even Point (BEP) in units (Fixed Cost ÷ Contribution per unit) and the C/S Ratio (Contribution ÷ Sales × 100). ICAN examiners at Foundation and Skills levels test (i) preparation of a marginal cost statement, (ii) computation of BEP, margin of safety and P/V ratio, and (iii) reconciliation of marginal-costing profit with absorption-costing profit using the change in inventory level multiplied by the fixed overhead absorption rate.

🟡 Standard — Regular Study (2d–2mo)

Standard content for students with a few days to months.

Product Cost vs Period Cost

Under marginal costing, only costs that vary with output volume form the product cost: direct materials, direct labour, direct expenses and variable production overheads. Fixed production overheads, fixed non-production overheads and fixed selling overheads are period costs — they are charged in full to the period in which they are incurred, regardless of inventory movement. This is the single behavioural difference between marginal costing and absorption costing.

Contribution and the C/S Ratio

Contribution is the amount remaining from sales revenue after deducting all variable costs (production + selling + administration). It is the amount available to cover fixed costs and contribute to profit. The C/S Ratio expresses contribution as a percentage of sales and is identical in value to the P/V (Profit/Volume) Ratio. ICAN questions often require you to compute:

Metric	Formula
Contribution per unit	Selling price − Variable cost per unit
C/S Ratio (%)	(Contribution ÷ Sales) × 100
BEP (units)	Fixed Cost ÷ Contribution per unit
BEP (₦ revenue)	Fixed Cost ÷ C/S Ratio
Margin of safety	Budgeted sales − BEP sales
Profit	Total contribution − Fixed cost

Cost–Volume–Profit (CVP) Behaviour

CVP analysis assumes selling price per unit, variable cost per unit and total fixed cost behave linearly within a relevant range. The break-even chart plots total revenue and total cost against units; sales activity above the intersection is profitable, below it is loss-making. The profit-volume (P/V) chart plots profit/loss against sales volume; its slope equals the C/S ratio and its X-intercept equals break-even sales.

Reconciliation of Profits

When opening inventory differs from closing inventory, reported profits under marginal and absorption costing diverge. The reconciliation identity is:

Profit (absorption) − Profit (marginal) = (Increase in inventory units × Fixed Overhead Absorption Rate) − (Decrease in inventory units × Fixed Overhead Absorption Rate)

In other words, the absorption-costing profit adjusts for fixed overhead carried forward in or released from inventory, while marginal costing writes fixed overhead off entirely in the period.

Typical ICAN Question Patterns

Prepare a marginal cost statement given split of semi-variable costs into fixed/variable components.
Compute BEP in units and in naira, margin of safety, and the sales volume required to earn a target profit of ₦X.
Reconcile the marginal-costing profit with an absorption-costing profit using an opening/closing inventory difference.

🔴 Extended — Deep Study (3mo+)

Comprehensive coverage for students on a longer study timeline.

Short-Term Decision Use of Contribution

For decisions whose time horizon leaves fixed costs unchanged (make-or-buy, special-order pricing, product mix, limiting-factor selection, temporary shut-down), the relevant measure is contribution per unit of the scarce resource, not profit per unit. Closing a department is justified only if the department makes a negative contribution after reallocating its avoidable fixed costs. A positive contribution still covers some common fixed cost and is therefore preferable to closure in the short run. Beware confusing contribution per unit with gross profit per unit — gross profit ignores variable selling overheads that must still be recovered.

Multi-Product Break-Even and the Sales Mix

A single-product BEP formula is misleading when more than one product is sold. The correct approach is to (i) compute each product’s weighted C/S ratio = Σ(product mix % × C/S ratio), then (ii) compute BEP revenue = Total Fixed Cost ÷ Weighted C/S ratio, then (iii) allocate the revenue across products according to the budgeted sales mix. Using an unweighted average C/S ratio is a classic ICAN trap.

Stepped Fixed Costs and the Relevant Range

Fixed costs are fixed only within a relevant range of activity. A stepped increase in fixed cost (e.g. hiring an additional supervisor at 8,000 units, another at 16,000 units) produces multiple BEPs — one per relevant range — rather than a single break-even figure. Always read the case to identify stepped costs before plugging a fixed-cost figure into the formula.

Limiting-Factor Analysis

When sales demand is not the bottleneck and a scarce input (raw material, labour hours, machine hours) caps output, rank products by Contribution per limiting factor, not contribution per unit. The optimal mix maximises total contribution subject to the limiting-factor constraint, and the chosen product mix feeds straight into the profit forecast.

Reconciliation Edge Cases

If closing inventory equals opening inventory, both methods report the same profit.
A decrease in inventory releases previously deferred fixed overhead, raising marginal-costing profit above absorption-costing profit.
Under- or over-absorption of fixed overhead in absorption costing flows into the reconciliation, not into the marginal-costing statement.

Common Mistakes to Avoid

Including fixed production overhead in product cost under marginal costing — wrong by definition.
Using full cost or profit per unit in a short-term decision instead of contribution per unit.
Treating the gross profit margin ratio as equivalent to the C/S ratio — gross profit ignores variable non-production overheads.
Forgetting to step up fixed costs before calculating BEP when activity exceeds the relevant range.
Reconciling profits without first restating absorption-costing stock at the fixed overhead absorption rate.

Practice Prompts (ICAN-style)

Prompt 1. A company sells one product at ₦1,200; variable cost is ₦600; fixed cost is ₦4,800,000. Compute (a) BEP in units, (b) BEP in naira, (c) margin of safety if budgeted sales are 18,000 units, and (d) sales units required to earn a target profit of ₦1,800,000.

Prompt 2. Opening inventory was 1,000 units and closing inventory 3,000 units. The fixed overhead absorption rate is ₦40/unit. Marginal-costing profit is ₦6,500,000. Compute absorption-costing profit and reconcile the two figures, commenting on the inventory movement.

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Marginal Costing